The Exchange

A New Way to Decode the Fed’s Muddled Message

Transparency is supposed to be a hallmark of democracy. Yet at the Federal Reserve lately, it may have become too much of a good thing.

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Reuters

The Fed has loosened up under Chairman Ben Bernanke, with scheduled press conferences, frequent candid remarks by senior officials and a deliberate effort to be less secretive. That’s a welcome contrast to the Fed under Bernanke’s predecessor, Alan Greenspan, who seemed to cultivate an aura of mystery through his famous cryptic pronouncements, followed by long bouts of silence.

But the Bernanke Fed has been so communicative in recent weeks that it’s been a bit like a dysfunctional family airing its issues in public. With traders anxiously guessing when the Fed might start to tighten its extreme loose-money policies, conflicting statements from Fed officials and central bankers in other countries have generated unusual churn in financial markets. “Central banks are struggling with their communication as they attempt to manage market expectations,” Patrick O’Hare of Briefing.com wrote recently. “Concern that central banks are not going to keep things propped up creates added volatility.”

Various statements from Fed officials have become so confusing that investment firm Keefe, Bruyette & Woods (KBW) recently created an “FOMC matrix” charting the views of every member of the Fed’s federal open-market committee, which sets monetary policy — including the “quantitative easing” investors are so concerned about. Of the 12 current voting members of the FOMC, at least six have hinted in recent remarks that the Fed might pull back on QE in the near future, if the economy improves enough.

Bernanke heartburn

Bernanke himself may have caused the most heartburn in markets, when he said during Congressional testimony on May 22 that the Fed could curtail QE “in the next few meetings,” which could mean a pullback in its most aggressive stimulus program by the fall. Since quantitative easing tends to boost stock values, stocks could fall once this occurs, which is why traders are intensely interested in the time frame.

Like other Fed officials, however, Bernanke qualified his statement with some important "ifs." In general, Fed policymakers say the job market still needs to improve and the economy needs to have clearly escaped the “fiscal drag” of tax hikes and spending cuts in Washington earlier this year.

One member of the FOMC, Esther George, has said repeatedly that the Fed should pull back sooner. In contrast, Chicago's Charles Evans has said the U.S. still needs the stimulus amid "unacceptably high" unemployment levels. Other members of the committee have been more circumspect, not saying much one way or the other. KBW points out that ordinary turnover among voting members of the FOMC will increase by one the ranks of the “hawks” seeking a pullback in QE next year.

A much bigger factor may be the departure of Bernanke, whose current term expires next January. Bernanke might win a third appointment if he wanted it, but reports suggest he’s had enough of the Beltway and is ready to move on. One theory is that Bernanke may want to leave QE unchanged for the rest of his term, leaving new initiatives to his replacement.

Some investors think the Fed will pull back on QE sooner than that, which is one reason the stock and bond markets have gone a bit haywire recently. The Fed may not even mind the confusion, since it forces investors to prepare for a market with less "artificial" support.

Still, the prevailing view is that QE will remain in full force until 2014, which the Fed may clarify at the FOMC meeting that concludes June 19. “The Fed wants to avoid whipsawing policy and would rather err on the side of caution,” KBW concluded in its FOMC-matrix analysis.

We’ll find out soon if the Fed wants to avoid whipsawing traders as well.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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